Month: October 2017

“Dancing On The Rim Of A Volcano”: Speculators Have Never Been More Short Volatility

With VIX ending Friday at its lowest weekly close ever, lowest monthly close ever, and lowest quarterly close ever – after the quietest September stock market in history – SocGen warned last Friday that the current situation is a "dangerous volatility regime" citing the strong mean-reverting tendency of uncertainty as a big reason for investors to brace themselves for trouble ahead.

Of course, judging by the new record short in VIX futures – extending last week's surge – the speculative public is as levered-long and complacent as it has ever been…

What could go wrong? SocGen's Arthur van Slooten explained late last week: "compare that with dancing on the rim of a volcano. If there is a sudden eruption (of volatility) you get badly burned"

Indeed, if CNN's Fear and Greed Index is anything to go by, investors are close to the 'most extreme' levels of greed in history…

However, it's not just volatility that is collapsing. Correlation has crashed, as JPMorgan's Marko Kolanovic recently pointed out.

Decline in correlations and parallels to 1994 and 2001

Over the past year, correlation of stocks and sectors declined at an unprecedented speed and magnitude (see figure below). A similar decorrelation occurred on only two other occasions over the last 30 years: in 1993 and 2000. Both of those episodes led to subsequent market weakness and an increase in volatility (in 1994, and 2001). The current decline in market correlations started following the US elections and was largely driven by macro (rather than stock-specific) forces. Expectation of fiscal measures, deregulation and higher interest rates set in motion large equity sector and style rotations. For instance, the correlation between Financials and Technology dropped to all-time lows (similar level during the tech bubble). The correlation between equity styles also dropped (e.g., Value was lifted by rates, and Low Volatility was impacted negatively). Declining correlations pushed market volatility lower (see here), and the ~25% market rally further suppressed correlations and volatility. To investigate what are potential implications for the future price action, we look at the 1993 and 2000 decorrelation events.

  • 1993/1994: Following the 1990-91 recession, interest rates declined and the market rallied. By late 1993, the market reached its highs (60% above recession lows) and volatility plummeted (VIX hit a record low on 12/22/1993). This also marked the low point of equity correlations. As interest rates increased in 1994, the market experienced a ~10% correction and posted a negative return for the year. Volatility and correlation increased, but the crisis was contained given the acceleration of growth (US GDP increased from 2.6% to 4.3% in the first half of 1994), and subsequent decline in bond yields.
  • 2000/2001: Following the 1998 crisis (LTCM, Russia), the market recovered and continued to rally. When the internet bubble was inflated, the market was 60% above 1998 lows. This period was marked with a strong decoupling of sectors (e.g., tech vs. financials), distorted valuations, elevated volatility and gradually rising interest rates. It ended with the tech bubble in March 2001, which marked the low point of equity correlation and start of recession. Subsequently, the market declined ~30%, bottoming in late 2002.

The current episode of correlation decline shares some similar features with both 1993 and 2000. The decline of correlation was in part driven by the market rally and elevated valuations; after a period of falling, interest rates are expected to rise (as in 1993), sector valuations (e.g., Internet) and sector rotations play an outsized role in market price action (similar to 2000), and record low levels of volatility increased the level of risk taking (as in 1993). Normalization of monetary policy will most likely lead to an increase of correlations and volatility, and that will at some point result in market weakness. While it seems that the 1993/1994 analogy is more appropriate (implying an orderly price action), investors should be aware of hidden leverage and tail risk of a more significant correction, such as the one in 2001.

Kolanovic concludes that "strategies that boost leverage when volatility declines, such as option hedging, CTAs and risk-parity, share similar features with the dynamic ‘portfolio insurance’ of 1987,” which “creates a ‘stop-loss order’ that gets larger in size and closer to the current market price as volatility gets lower.”  Additionally, growth in short-vol strategies suppresses both implied and realized volatility, and with volatility at all-time lows “we may be very close to the turning point.”

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FX Week Ahead: Blind Faith – First It Was In The US, Now It’s The UK

Submitted by Shant Movsesian and Rajan Dhall MSTA from fxdaily.co.uk

We have seen many instances of blind faith driving the rates and currency market, with last year's post Trump victory reflation trade the leading example.  Promises of policy reform focused on taxes and health-care lead many to anticipate a growth busting administration in full flow, but as we have seen, the vociferous and controversial president has had it anything but his own way.  Of late, there have been seeds of optimism with his address in Indiana highlighting the more specific changes he will push for in Congress including corporation tax no higher than 20%, a three level tax rate system and simplified coding which will make returns easier to fill out. None of this will generate USD strength in the meantime unless there are genuine prospects of getting through, but both Steve Mnuchin and Gary Cohn believe this is achievable, so it is now a case of wait and see – the markets will naturally remain sceptical.  

Nevertheless, we have been calling for a USD correction among the minority, and having recovered some ground over September, the greenback has edged back to levels where USD bears will start to see value in reinstating their longer term view. This will be selective however, and in that respect, levels in USD/JPY but less so USD/CHF look a little vulnerable under the circumstances above.  US Treasury yields have recovered well, and show little sign of an immediate return to the recent lows, with some of the data as well as a little more commitment from Fed Chair Yellen bolstering for now.  He more pertinent comments were that rate rises will not be 'too gradual', and this along with some of the growth metrics have put a Dec rise in Fed Funds firmly back on the table.   Job done, the market will now be looking to 2018 to judge whether further USD gains a justified, with the 10yr T-Note faltering a little above the 2.30% mark, where higher up we expect 2.50% to hold firm.  USD/JPY will struggle to improve materially on 113.00+ as a result, and as we have already seen in the past week.

Plenty of data in the run up to Friday's major risk event which is the Sept non farm payrolls report, but don't expect any firework's in the numbers or indeed the response as the Hurricanes distort the readings to immeasurable levels.  ISM manufacturing PMIs may perhaps be a better gauge of economic activity given the above, so Monday's release may well set the tone for much of the week.  More data in the ISM NY business conditions on Tuesday and non manufacturing PMIs on Wednesday alongside the ADP survey.  Aug Factory orders to look for on Thursday. 

So back to blind faith, and nowhere is this more so prevalent than in rate pricing in the UK, where the market has been hanging on the words of BoE governor Carney and his fellow members who have also prompted the market to (re-)price a 25bp rate hike this year and more beyond.  Last Aug we saw a panic move cut the base rate from 50 to 25bps and at the time I was among others who thought this was a policy mistake, and nothing has changed my mind since, instead believe now they have (already) made another one.  Following on from Messrs Saunders and McCafferty, Vlieghe (who was said to be keen for the rate cut last summer) and Broadbent have helped tip the balance of power towards the hawks along with the governor himself and implied rates have shifted higher and will no doubt see the banks preparing to adjust mortgage rates accordingly.  Should they temper their signal – as I believe they should – that this is a case of one and done (in reversing last year's move), then we should see some moderation in the 10yr which has touched 1.40% this week, and the Pound should come back a little in response.  

Having met with strong resistance above 1.3600 in the week before last, there are plenty of traders who were and are ready to fade this move, and irrespective of some of the data showing signs of resilience in the economy with positive results and surveys from the high street as well as the unemployment rate easing back to 4.3%, few see higher inflation levels as a healthy development in light of the impact this will have on disposable incomes.  The BoE tell us that household debt is not a concern at present, but we have heard this in the past, and with Brexit hanging over the UK, this is not time to be calling a recovery in process and one which warrants the start of a tightening cycle.  

That said, we are not expecting an outright collapse in the Pound.  At 1.2000, we saw value in Cable given the circumstances at the time, but with Article 50 now triggered and the negotiations under way, little has changed despite the recent press conference revealing constructive talks.  Thankfully, EU citizenship is finding common ground, given peoples lives are impacted, but those who believe that any agreement on the exit payment (which is still far off) will lead to positive developments on trade and single market access, will be left disappointed.  On this, we believe the mid 1.30's are not a platform for a move to 1.4000 let alone 1.4500.  EUR/GBP may have also set its base at 0.8750 or so as a result, though we still see a small probability that this may be extended closer to 0.8600.  

This will likely depend on whether the EUR/USD correction has run its course to the low 1.1700's, and as yet, we are not convinced.  Nothing has really changed on the political scene in Germany to have led directly to the move back to 1.1800, which in itself is a modest upturn as yet, but any sign of coalition agreement then the upside will have further to run.  Even so, we still expect to see much of the price action here as consolidative in the near term, and the option market seems to agree as the lower delta risk reversals have aligned with the 25's to suggest a range of 1.1600-1.2300, potentially into year end.  We see the downside as the more vulnerable, with market dynamics pointing to the upper levels as exhausted but still open to modest extension rather than an outright resumption to trend.  

Manufacturing PMIs are the highlight of the data schedule in the Euro zone next week, due out on Monday, but on Thursday we get the ECB minutes which can have some interesting additions – currency 'mentions' have surprised more recently.  Draghi speaks the day before.  German factory orders on Friday will be of interest after the weak stats in Jul.

UK data points to focus on ahead lie in the UK PMIs, the services component of which is on Wednesday, but Theresa May's party conference starts this week, and pundits will be watching for any deviation on Brexit from here speech in Florence. 

Over in Canada, currency appreciation has had little more substance behind it with the BoC having raised rates by 25bps in 2 consecutive meetings.  Alongside the second hike, the statement highlighted this as the removal of stimulus measures effected in 2015, but the market went on to price in more until governor Poloz decided it was time to manage expectations once again.  Before his address last week, we saw the Canadian 10yr rate touching 2.20%, along with a 50/50 call for another move in October.  We can rule this out after his comments that rates are not on a predetermined path – they never are – but the latest data also suggests caution in the market, which saw the sweeping tide of CAD buying take us into the mid 1.2000's.  Too fast too soon? Yes, but that's not to say the longer term picture does not favour fresh upside.  Moderation is what is required here, but we seldom get it in a fast money environment. At 1.2500 again, the BoC can stand easy for now, though we still see room for the yield curve to moderate a little further, and this may well push up the correction to test into 1.2600-1.2800 initially.  

Canada also releases its jobs report next Friday, the last one of which saw sizable shift back from full to part time jobs.  GDP for Jul was also flat as seen Friday last, and Thursday's trade data could signal whether we should expect more of the same and the rapid CAD appreciation (10% in 3 months) was to blame.  

Over in Australia, the RBA meet on Tuesday, but judging by the rhetoric from governor Lowe, few will be expecting anything other than a neutral and cautious statement.  No change to rates here this time or indeed any time soon given last week's address and it has hard to see anything changing his or the board's view since then.  There will be room for some positive aspects to be considered, not least of all improvement in Q2 GDP and a healthy jobs market, so it's not doom and gloom either – just neutral.  

Over the weekend, both the official and Caixin manufacturing PMIs were released due to the Chinese holiday next week, but with divergent results.  The former saw a rise from 51.7 to 52.4 in Sep, while the Caixin index fell from 51.6 to 51.0, so the response in industrial metals price at the start of the week will show which one the market is ready to believe – and AUD will follow.  

Nothing out of NZ other than the Global Dairy Auction on Tuesday, but politics dictate the market here also after another election results in a hung Parliament.  Along with the 'neutral and cautious' (you are going to hear this a lot) RBNZ statement, we saw NZD brushing off the ill effects of last weekend, and indeed has resumed the upside vs the AUD as the cross rate continues to hover over the recent lows around 1.0825.  

In Japan, the Tankan survey – which was a market mover back in the 1990's – will be viewed from a longer term perspective given the BoJ's devotion to getting inflation back to target.  While some have questioned their 'ambitious' objective, others see the 2.00% level as arbitrary in the current climate, but steadfast are the central bank to the accommodation in policy, while sticking to yield control in the 10yr.  

When the JPY decides to turn and trade off domestic fundamentals is something to consider much further down the line, but worth watching for now, with periodic bouts of risk aversion the only positive driver – which then leads to an unfavourable pace of gain.  Divestment flow is now a market staple in times of positive risk mood, but noticeable is the general growing appeal of Japanese stocks in recent months and this could start to weigh on all JPY pairings, limiting the upside in both the good and (naturally) bad times.  For USD/JPY, we see circa 114.00 as a key area going forward.

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Here’s How Much of Your Taxes Have Gone To Pay For Wars Since 9/11

Submitted by Stock Board Asset

Previously unreported Pentagon data shows how much the average U.S. taxpayer has paid for combat operations in Afghanistan, Iraq, and now Syria. According to the two page report summary, the cumulative estimated cost of the 16 year war in the Middle East has cost each taxpayer $7,500.

According to Defense One, Americans paid the most for the wars in 2010, an average of $767 per taxpayer. Since the peak, the annual amount has declined to $289 this fiscal year and $281 projected for 2018. By October of 2018, the Pentagon’s share of the wars in Afghanistan, Iraq and now Syria will have collectively cost taxpayers more than $1.5 trillion, according to the Department of Defense.

On the other hand, the Watson Institute at Brown U. tells a different story of the actual cost of war coming in at a staggering $4.8 trillion on a post 9/11 basis, and since this spending has been funded through new debt issuance, interest on the borrowed funds could climb to $7.9 trillion by 2053.

According a paper by Columbia University economist and former chief economist of the World Bank Joseph Stiglitz and Harvard University’s Linda Blimes, former US President George W. Bush’s economic adviser Larry Lindsey touted that war costs would be capped near $200 billion when pitching the Iraq War, which he thought would be “good for the economy.”

The economists wrote that “it now appears that Lindsey was indeed wrong – by grossly underestimating the costs.” They determined that $750 billion to $1.2 trillion had been spent on the Iraq invasion alone, three years after the conflict started (2006). Now, 11 years after their paper, the Pentagon actually says that the Iraq, Afghan, and Syrian conflicts combined have summed just $1.5 trillion”.

On a historical basis, the Pentagon has had a checkered past when it comes to accounting. In 2001, Donald Rumsfeld told the American people, the Pentagon could not account for $2.3 trillion or $8,000 per American citizen.

Last August, the Pentagon did it again and according to a shocking government report, somce $6.5 trillion in taxpayer funds were unaccounted for due to “accounting error.”

Considering the trillions in taxpayer funds spent to prop up the US defense industry, and the staggering amount of “accounting inconsistencies” inside the DOD, it is safe to conclude that America’s war machine will be very busy in the coming years, making shareholders of the military-industrial complex richer with every passing year.

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Puerto Rícan Cop Calls Radio Show in Tears: ‘It’s An Abuse, It Looks Like Communism’

An anonymous Puerto Rican police officer called New York’s largest hispanic radio station, 97.9, to complain about the Mayor of San Juan, Carmen Yulín Cruz, and the Governor, Ricardo Rossello — saying they are putting on as grande show for the cameras, which is costing lives.

In a riveting 6 minutes on air, this anonymous police officer gives her take on things and how the Puerto Rican government is failing to provide people with basis necessities all because of politics.

“What they are doing, it’s an abuse. It looks like communism, in our own island. Let me tell you something, Boricuas are dying of hunger. The medics here, people are dying. The hospitals are in crisis.”

Her request: “we want the US to come in and take the Governor out. He is not doing anything. He is just around and around and everyone is like ‘oh how nice, the governor, he is going into the mud. He’s going into the water.’ And where is it? WHERE IS THE FOOD?”

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Puerto Rico Cop Says Mayor Of San Juan Sabotaging Hurricane Aid For Political Gain

Content originally published at iBankCoin.com

The mayor of San Juan, Puerto Rico has been accused of withholding food and supplies from residents of the island’s capital in order to milk maximum publicity and political capital from the disaster, according to a caller to a New York City Hispanic radio station who identifies herself as a Puerto Rico police officer from the San Juan suburb of Guaynabo. The officer reported that San Juan mayor Caren Yuliz Cruz is guilty of “staggering negligence and dereliction of duty in the wake of Hurricane Maria,” GotNews.com reports.

 

Via GotNews: 

The police officer begins by pleading with the U.S. Military to go directly to the people of Puerto Rico with its aid, as current efforts to work through Governor Ricardo Rossello and Mayor Cruz are proving futile. “What us Puerto Ricans need is the U.S. Armed Forces to come in and distribute the aid. And that they stop the Governor, Rossello, and the Mayor, Yulin, from continuing on doing what they’re doing. It’s an abuse; it looks like communism, in our own island.”

“There are dozens and thousands and thousands of food [boxes] and when people ask, we cannot give anything away because Carmen Yulin says that we cannot take anything out, because everything is a soap opera here – everything is a show,” the caller explains. “There have to be cameras here and there because, you know, they are just looking for votes for the upcoming years.”

“Carmen Yulin won’t move unless there is a camera behind her,” the caller continues. “I need to speak for the people because the people are suffering. Because I, as a cop – along with other police partners – we are seeing it.”

Meanwhile 

Mayor Cruz, who praised FEMA just five days ago before remembering she’s a Democrat – turned around on Friday and told CNN that FEMA and President Trump had offered no help in front of a giant stack of US aid pallets.

“We’re dying here, and I cannot fathom the thought that the greatest nation in the world cannot figure out logistics for a small island of 100 miles by 35 miles long. So I am asking the president of the Untied States to make sure somebody is in charge that is up to the task of saving lives.”

“If anybody out there is listening to us, we are dying. And you are killing us with the inefficiency and the bureaucracy.”

 

Fox’s Geraldo Rivera pretty much shut that down:

President Trump, meanwhile, responds:  


Sad!

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“Tax Reform Is A Pipe-Dream” – Stockman Warns Market Is Heading For Massive Crash

Having raged against President Trump's '1500-word-airball' of a tax reform plan, the Reagan administration's director of the Office of Management and Budget, David Stockman told CNBC this week that Wall Street is "delusional" for believing it will even be passed.

"This is a fiscal disaster that when they [Wall Street] begin to look at it, they'll see it's not even remotely paid for. This bill will go down for the count," said Stockman.

He said White House economic advisor Gary Cohn and Treasury Secretary Steve Mnuchin "totally failed to provide any detail, any leadership, any plan. Both of them ought to be fired because they let down the president in a major, major way."

Stockman pulled no punches about President Donald Trump…

"You get a black swan in the old days, or maybe you get an orange swan now, the one in the Oval Office who can't seem to stop tweeting and distracting the whole process from accomplishing anything."

Reaffirming his thesis that the stock market rally is in serious trouble…

"There is a correction every seven to eight years, and they tend to be anywhere from 40 to 70 percent," Stockman said recently on CNBC's "Futures Now." "If you have to work for a living, get out of the casino because it's a dangerous place."

 

"This market at 24 times GAAP earnings, 21 times operating earnings, 100 months into a business expansion with the kind of troubles you have in Washington, central banks [are] going to the sidelines," he said.

 

"There's very little reward, and there's a heck of a lot of risk."

Stockman puts a big portion of the blame on the Federal Reserve, and its ultra-loose monetary policy.

"This is a bubble created by the Fed," he said.

 

"We're heading for higher yields. We are heading for a huge reset of pricing in the risk markets that's been based on ultra-cheap yields that the central banks of the world created that are now going to go away because they're telling you that they're done."

Full interview below:

Stockman: Stocks to plummet 40-70% from CNBC.

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Has The World Gone Nuts?

Authored by Mark Melin via ValueWalk.com,

The notion that investors are “reaching for yield” when investing in risky sovereign bonds has become too much of a cliché for Macquarie’s Victor Shvets. The problem is that concept provides easy cover, a limp excuse for bond investors making obviously flawed decisions, as was the case during the Petrobras 100-year bond offering. Those same set of circumstances appear to again be taking hold across the emerging market landscape, and institutional investors are falling into the same trap.

While trusted research reports were touting the Petrobras 100-year bond deal, certain investors, most notably Bridgewater Associates, took the opposing point of view. To the world’s largest hedge fund, it was obvious the emperor had no clothes. Despite all the usual suspect consensus analysts gushing over the prospect of 100-year Bond offering with exposure to a scandal-tainted enterprise amid a government with a history of instability, there were mathematical reasons to question the offering.

Nonetheless, “yield-starved” investors piled in – and the result was a tragedy.

The same situation appears to be playing out in far-flung regions of the world such as the Ivory Coast. Investors were lining up outside the door and around the corner to get a chance to purchase bonds yielding 6.25%. The June 2017 sovereign bond offering attracted US$10 billion in bids for US$1.9 billion in issuance for 16- and 5-year exposure to an unstable government.

When evaluating the Ivory Coast investment prospects, the question is: Where in the modeling did it account for default? How much loss potential was factored in when evaluating the potential for a 6.25% annualized return?

Factoring in bond default and restructuring would appear as an obvious consideration by looking at the nation’s history since it gained independence from France in 1960. Shvets categorized the nation as a “state wrecked by coups and civil wars” but more importantly it has been “a serial defaulter.”

It doesn’t take a history major to figure out past bond investments have statistically involved a meaningful degree of default risk. In 2011 it simply stopped bond payments that were issued due to a restructuring of 2010 bonds, which themselves were part of a restructuring of loans made in the 1970s and 1980s.

But it’s not just the Ivory Coast.

Investors are loading up on Iraqi and Greek five-year bonds at 6.75% and 4.63% respectively, making them a relative deal compared to 16-year Senegal bonds paying 6.25% and “serial defaulter” Argentina’s 100-year bond offering that yields 7.92%. While Argentina’s government is currently “pro-market,” that could easily change over the next 100 years – if not the next ten years. But if you don’t want to commit capital for 100-years to a traditionally unstable government, perhaps the slightly higher yield in Ukraine’s ten-year bonds at 7.3% might do – so long as investors ignore its location in the middle of a war zone.

Shvets is flabbergasted. “How can one rationalize such investor behaviour?”

The excuse of investors “reaching for yield” no longer does justice to such investments, he says, pointing to the only logical thesis being central banks being unable to normalize interest rates – or this is just a bubble that will burst like all others.

Pensions and other institutional investors are in a tough predicament. With yields in the developed world knuckle dragging at or near negative on a real, inflation-adjusted basis, there are not many “safe” yield chooses – and the situation might not correct itself. Over the long term Shvets muses that “there is no alternative” to the “unorthodox monetary policies” he sees playing out into “perpetuity.”

But is there "no alternative" to an Ivory Coast bond offering?

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A $1.5 Trillion “Quantamental” Market Opportunity

While the debate rages if retail investors have eased on their boycott of the stock market, making it increasingly difficult for institutional investors to dump their holdings of risk assets to Joe and Jane Sixpack even as active investors continue to suffer unprecedented redemptions amid a historic shift from active to low-cost, factor-driven passive management, in today’s Sunday Start note from Morgan Stanley Andrew Sheets, the cross-asset strategist points out that the next $1.5 trillion market opportunity may be a fusion of retail and institutional preferences, namely a low-cost quant approach to investing, coupled with a legacy, fundamental strategy.

As Sheets writes, “$1.5 trillion of AuM currently managed under quantitative guidelines could continue its double-digit growth over the next five years. Part of this growth is a  ‘pull’ from investors broadening their search for risk premium and uncorrelated returns at lower fees than traditional alternatives. Part of this is a ‘push’, as asset managers see systematic strategies that lend themselves well to automation and scale, offering value over pure ‘beta’ in a traditional active management framework. Relatively small further reallocation by asset owners towards these strategies could still drive significant growth.”

And while that may come as soothing words to asset managers scrambling to shift from fundamental to a fusion, or “quantamental” investing approach, Morgan Stanley then sets a cautious tone asking whether “this growth is occurring at the wrong time” pointing out that “there are serious concerns over whether the flow we’ve already seen into these strategies explains a recent deterioration in performance, and is leading to a dangerous ‘crowding’ of too much money chasing the same factors.”

This goes to the whole “ETFs are socialist products which are destroying both portfolio selection and capitalism, and making markets illiquid, fragmented and at risk of seizure” argument that has been discussed here over the past few years.

For the record, Morgan Stanley is not too concerned, and instead casts the blame on the “unusual environment of distortive central bank policy, an EM and commodity bear market, and high asset correlation. Those dynamics, we think, offer a better explanation for why performance was poor, and incidentally, are all in the process of rolling back.”

What about crowding? According to Morgan Stanley, “this debate is hotly contested, especially as we’ve marked the 10-year anniversary of the ‘quant crash’ in mid-2007. It is difficult to resolve, especially because things don’t need to be popular to have problems, and well-liked strategies can persist for extended periods of time. So we’ll shift the question: Are factors much more expensive than normal (relative to the market), perhaps because of these flows?“

For the answer, read the full note from Andrew Sheets below:

Quant and Fundamental – Better Together

 

 

We expect significant further growth in assets that are managed with some form of quantitative mandate. That has implications for markets, and for investors trying to navigate them. Later today, we’ll be publishing a detailed analysis of these issues, with a focus on what we see as the most notable opportunity – increasing fusion between fundamental and quantitative approaches. Consider this a preview.

 

My colleague Michael Cyprys estimates that ~US$1.5 trillion of AuM currently managed under quantitative guidelines could continue its double-digit growth over the next five years. Part of this growth is a  ‘pull’ from investors broadening their search for risk premium and uncorrelated returns at lower fees than traditional alternatives. Part of this is a ‘push’, as asset managers see systematic strategies that lend themselves well to automation and scale, offering value over pure ‘beta’ in a traditional active management framework. Relatively small further reallocation by asset owners towards these strategies could still drive significant growth.

 

This ~US$1.5 trillion estimate casts a wide net, from funds that explicitly emphasise a factor like ‘value’ to those doing sophisticated, systematic multi-asset trading. Yet despite this range of complexity, the underlying premise of a rule-based approach is generally the same. Our work focuses on a key building block, factors, which can be thought of as the answer to questions such as “what if every month I just bought cheap stocks and sold rich ones, or bought high-carry and sold low-carry FX, and did that over and over and over again?”

 

The answer is interesting. There is a litany of work showing the existence of risk premium for these factor strategies over time. We aim to add to this debate by looking at factors from the micro (stock) to macro (asset class) level, globally. Combining the work of Brian Hayes on equity-level factors with work by my colleague Phanikiran Naraparaju on macro ones, we see an encouraging case for diversification, given the (low) correlation of factors to the market and with each other.

 

But is this growth occurring at the wrong time? There are serious concerns over whether the flow we’ve already seen into these strategies explains a recent deterioration in performance, and is leading to a dangerous ‘crowding’ of too much money chasing the same factors.

 

Let’s start with recent performance. Over the last five years, systematically trying to own things with better value, carry or momentum has done worse than the long-term average. This is true whether you’re looking at the micro world of stocks or the macro world of asset classes. But we’re not sure that investor flows explain this. First, we’d venture that ‘too much money’ chasing strategies would have the opposite effect, causing these strategies to over-earn.

 

Second, this period covers an unusual environment of distortive central bank policy, an EM and commodity bear market, and high asset correlation. Those dynamics, we think, offer a better explanation for why performance was poor, and incidentally, are all in the process of rolling back.

 

Which brings us to crowding. This debate is hotly contested, especially as we’ve marked the 10-year anniversary of the ‘quant crash’ in mid-2007. It is difficult to resolve, especially because things don’t need to be popular to have problems, and well-liked strategies can persist for extended periods of time. So we’ll shift the question: Are factors much more expensive than normal (relative to the market), perhaps because of these flows?

 

Our work suggests the answer is often ‘no’, with valuations on a majority of factors at both the stock and asset class level closer to long-term averages than extremes. This doesn’t mean there isn’t a risk of drawdowns from automated strategies, but we do think it mitigates this risk, as expensive factors would have further to fall.

 

However, these risks bring us to our main point – the opportunity in combining quantitative and fundamental approaches. We think that quantitative approaches can benefit from passing through a level of fundamental scrutiny, and fundamental investment analysis can benefit from being aware of where factor exposure exists.

 

These aren’t, we’d argue, just general platitudes. At the micro level, work by our equity quantitative strategists has shown that stocks favoured by quantitative screens and Morgan Stanley analysts do better than either alone. At the macro level, our new systematic framework for scoring cross-asset factor exposure (CAST) suggests that even simple, unoptimised approaches of screening assets can improve macro calls. For all their promise and sophistication, systematic strategies in financial markets can still struggle with limited data and the difficulty of adapting to regime shifts. Amazon, for example, has scored poorly for years on ‘value’ and ‘carry’. It has still done quite well.

 

At the same time, if factors do tend to produce positive returns over the long run, why wouldn’t fundamental analysts want to know about them? At the very least, we like the idea of knowing which of our calls are aligned (or misaligned) with value, carry and momentum. And as we search for new views, we look for which assets might have all those properties that we’ve inadvertently missed. At present, assets that our strategists like fundamentally, and also screen well on a factor basis, include Chinese equities and RUB, whereas CHF and JPY screen poorly and are disliked by our strategists.

The implications of the above, if taken to their logical extreme, are concerning: what Morgan Stanley is saying is that contrary to centuries of conventional financial wisdom and study, fundamental, value investing is no longer a key driver of future returns, and instead the things that do matter in this “market”, include what the consensus algo, or robotic trade du jour is, and what quant factor will define returns over the immediate future period.

In other words, the math PhDs have officially taken over. It also means that for the sake of all those legacy traders and investors who learned finance the “old-fashioned way”, they better have practical skills that are applicable far away from what was once Wall Street, and is now just a bunch of algos frontrunning each other and the Fed.

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Blowback? NFL Ticket Sales Crash 17.9% As Owners Lose Control Of Players

Probably just a coincidence… or just transitory, but The online ticket reseller TickPick told The Washington Examiner that sales have dropped 17.9 percent, far more than the usual Week Three fall…

  • 17.9 percent decrease in NFL orders this week compared to the previous week.
  • Last year the drop was 10.8 percent in orders on Monday & Tuesday following Week Three games.

"We have seen a massive decrease in NFL ticket purchases this past week in comparison to years past. Week 3 seems to usually have less ticket orders than week 2, but this year ticket purchases are down more than 7 percent from this time last year," said TickPick's Jack Slingland.

"While we can't specify if this decrease is due to the president's comments, player and owner protests, play on the field, or simply the continued division of consumer's media attention, the conversation around the NFL this week has focused on the president's comments as well as the players' and owners' reaction. As viewers continue to abandon their NFL Sunday habits, both the number of ticket sales and the purchase price of tickets will drop," he told us.

And despite orders from The NFL that players will stand for the National Anthem this week, The Hill reports that at least three Miami Dolphins players (Julius Thomas, Michael Thomas, & Kenny Stills) took a knee during the playing of the national anthem Sunday.

Saints players took a knee before the anthem began, but then stood as it was played.

But as ESPN reports, NFL owners are struggling to retain control of their players…

"It certainly was my takeaway that the commissioner was looking for a way for the protests to end," DeMaurice Smith (NFL Players Association executive director) said Friday when asked about his 30-minute conversation with Goodell (NFL commissioner), while declining to offer specifics about what was discussed. Goodell declined to comment, but a league source did not dispute Smith's account.

 

"Knowing the league the way I know the league, they are first and foremost concerned about the impact on their business," Smith said. "That's always their first concern. I mean, who are we kidding?"

 

Nobody was kidding when many of the NFL's highest-profile owners, including Robert Kraft of the New England Patriots and Jerry Jones of the Dallas Cowboys, expressed concerns last week that the optics of hundreds of players kneeling, sitting or remaining in the locker room during the playing of the national anthem had alienated many fans at a particularly perilous moment for the NFL.

 

TV ratings for many of this year's games have continued a slide that began last season; some league sponsors have grown skittish about the backlash; and most surveys have shown that a majority of NFL fans are turned off by the politicization of the game.

To the commissioner's suggestion that the protests should end, Smith said,

"My only response was, 'I don't have the power to tell our players what to do.' … At the end of the day, this is a group of players who are exercising their freedom.

 

There is no room for me to snap my fingers and tell our players, 'It's time for you to give up a freedom.' Just the idea offends me. It's almost as if the players are being asked, 'What's it going to take for you to stop asking to be free or to be treated like an American?'"

Early on, one of the players pointedly told the assembled owners — in particular Kraft, who this year gave his longtime friend Trump a Super Bowl 51 champions' ring — "We know a lot of you are in with Trump. This meeting is going on because the players think that some of the people that they work for are with his overall agenda, and that's not in the players' favor."

"We can't just tell them to stop," Goodell said of the players' protests.

Many owners immediately argued otherwise.

"We need to find a way where Trump doesn't win," one said, and that meant using leverage as employers to end the protests.

 

Another said, "We'll get our guys in line."

Political infighting contonues to stink up the place…

Some owners were angry that Joe Lockhart, the NFL's executive vice president of communications who worked as President Bill Clinton's press secretary, had told reporters on a Monday conference call that the players' words and actions on the subjects of police brutality and racism were "what real locker room talk is."

 

It was a brazen shot at Trump, who was captured in a 2005 video talking, in explicit terms, about grabbing women by their vaginas but later dismissed the video's contents as "locker room banter."

 

Owners, many of whom had supported Trump and seven of whom had donated at least $1 million to him, felt that Lockhart had unnecessarily politicized the league's response.

 

One owner barked angrily at Lockhart, who declined to comment about the matter, echoing a sentiment that most of them — especially Jones — shared: Nobody wanted to engage in a political mud fight with the White House, even if "they were all pissed at the president," a league source said.

As ESPN concludes, by the end of their meetings, the players and owners weren't as unified as they would later publicly state, but as one owner says, "We've gotten out of crisis management and into, 'How do we do this correctly?' There was a chance that we didn't deal with it correctly — and it had passed."

Perhaps after this week's collapse in ticket sales – and potentially a few more lost advertising dollars – the owners may have some different ideas on how to control their players in their place of work.

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Watch Live: Spanish Prime Minister Rajoy Explains Why His Police Force Is Beating Peaceful Catalans

Four days after meeting with President Trump, who ‘hoped’ Spain would stay ‘united’ and that “secession would be foolish,” Spanish Prime Minister Rajoy is set to address the nation to explain why he sent his brutish military into Catalonia to stop people of his nation from exercising their free will to vote, injuring over 400 in the meantime. 

The Spanish government has opposed the referendum, deeming it “illegal” and “unconstitutional”.

Political leaders outside Spain had publicly backed Rajoy to enforce the law ahead of the vote.

Here was Trump and Rajoy last week…

President Trump said Tuesday that the United States opposes an independence drive in the Spanish region of Catalonia, telling reporters that such secession would be “foolish.”

“I think Spain is a great country, and it should remain united,” Trump said during a news conference with the visiting Spanish Prime Minister Mariano Rajoy.

The president’s remarks mark a departure from the official position of the United States, which, as recently as Monday, was that a planned nonbinding Catalonia referendum Sunday to separate from Spain was an internal matter.

State Department spokeswoman Heather Nauert had said earlier this month that the United States took no position on the referendum.

“We will let the government and the people there work it out, and we will work with whatever government or entity that comes out of it,” Nauert said.

But images of Sunday’s crackdown tested that backing…

“It’s a huge PR disaster for the Spanish government. It’s hard to justify the police beating up people,” said Angel Talavera, an analyst at Oxford Economics in London.

 

“We are going to see the secessionists start to try to win more international support. They will present the events as evidence for their thesis that they are up against a repressive regime.”

And tonight’s live feed from Rajoy to explain the debacle that is occurring in Barcelona and across the region (due to begin at 1415ET):

Remember, as we noted yesterday that “if Catalonia secedes from Spain…in terms of the debt sustainability parameters laid down by the Treaty of Maastricht, it’d be the Eurozone debt crisis 2.0…”

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